Venezeula Economy Essay

Starting in the 1990’s economic turmoil began to spread throughout South America. Venezuela was not immune to these economic problems. The once-thriving country experienced high levels of inflation and poverty, the result of a number of factors. This paper intends to examine Venezuela’s economy and the effect that inflation has on Venezuela, the United States, and the world banking system.

Economists differ in their views about whether the decision to lift the band restriction on the Bolivar will help ease inflation. I agree that by lifting the band restriction Venezuela can start to emerge from the current recession. The Venezuelan government must allow the Bolivar to set its own value in order to see how the Venezuelan economy is functioning. Venezuela has been struggling with high inflation for the past decade. It is important to see how Venezuela’s economic problems started and how the government’s recent actions will affect the Venezuelan economy.

In order to see the effects of inflation on Venezuela, it is necessary to examine Venezuela’s economy. Unlike many other South American countries, Venezuela has a large quantity of natural resources. For a long time the economic success of Venezuela depended heavily upon these resources. In Georgie Anne Geyer’s article “Poor Rich Venezuela”, she interviews a number of important Venezuelan leaders. One such leader is Arturo Uslar Pietri, who is the country’s most highly respected scholar. Pietri says, “Venezuela is the richest country in Latin America, by far”. In order to see how such a wealthy nation could be faced with such high unemployment and poverty, we need to examine the foundation of Venezuela’s economy.

Three major factors have a direct influence on the health of the Venezuelan economy. The first is the mining industry, which is by far the most important to the success of Venezuela’s economy. The second is the reliance on the United States for the majority of Venezuela’s imports. Finally, but extremely importantly, is the continuing political turmoil taking place in Venezuela. Of course other factors contribute to the economic situation in Venezuela, but these three factors influence both the inflation index and the economic growth of the country.

As stated before, the mining industry has a direct influence on Venezuela’s economy. Statistics show that 76% of Venezuela’s exports are directly related to the mining industry. Oil is the major export from Venezuela. The United States is responsible for the majority of these oil exports. Venezuela boasts one of the largest oil supplies outside of the Middle East. Because of the oil reserves Venezuela plays a major role in the Western Hemisphere as well as in world politics. Since Venezuela depends so heavily upon oil revenues, Venezuela’s economy rises and falls with the price of oil. Oil, traditionally being a highly volatile commodity, can cause drastic changes in the Venezuelan economy. During the 1990’s, when oil prices were low, Venezuela’s financial status declined along with the price per barrel of oil. For years Venezuela’s governments depended heavily on oil revenues to drive the economy. This heavy dependence on oil leads to deterioration of other industries that could have held the economy stable during the oil recession. Adding to Venezuela’s dependence on the mining industry are the large quantities of iron ore deposits, and coal deposits. Venezuela also is said to have 12% of the world’s gold supply deep in its mines.

Because the Venezuelan government places such emphasis on mining, the manufacturing industries have almost become non-existent. The lack of a manufacturing base forces Venezuela to import a majority of everyday products from other countries. Juan Pablo Toro, in an article for The Oil Daily says, “ The fact that Venezuela imports 60% of its products from North America and 30% from Colombia leaves little trading room for other South American economies”. During the 1990’s, 40% of Venezuelan imports came directly from the United States. With such a high dependence on the United States for these manufactured goods, the Venezuelan economy is closely tied to the growth or loss experienced in the U.S. In a graph found in Business Guide to Venezuela it shows the following breakdown of imports. One of the most frequently imported goods is equipment to run the countries oilfields. These supplies include oilfield pumps and drilling and boring machines. The Venezuelan government, in its efforts to implement a nation-wide telephone system, is forced to import a large quantity of transformers. Most of this telecommunication equipment comes from U.S. suppliers. Like many other South American countries, Venezuela depends heavily on imports to meet both its automotive and consumer needs. Many used American cars are shipped to Venezuela because Venezuelan factories cannot meet the demand for cars.

Venezuelan President Hugo Chavez won the Presidency with promises of political and social reform. However, most of these changes have yet to take place, and President Chavez has already started to lose the support of both the military and the increasing population of poor people. Venezuelans have long dealt with the corruption in the oil industry, but now this corruption is creating distrust in the current President’s goals of nationalizing the country’s oil supplies. Many respected government officials blame the lack of checks and balances on the continuing corruption that affects both the United States and Venezuela. An overall distrust between the Chavez administration and his opposition has caused a rift to form, causing many decisions to be painstakingly slow. In “Lenten Diet,” an article in The Economist, the role of political turmoil is focused upon. The author states, “But the President scarcely mentioned the other main cause of the economy’s troubles: continuing political turmoil, which has provoked capital flight”. Basically the author feels that, because of political uncertainties, many would-be investors are scared to sink substantial funds into Venezuela. Jorge Giordani, a planning minister and critic of Chavez, is quoted in “Lenten Diet” as saying, “His (President Chavez) aggressive rhetoric and rule by decree have alienated almost every

Interest group, from businesses and the unions to the Catholic Church and the media”. Because of such turmoil, Venezuela has become less attractive to investors and this has a direct influence on the economy by promoting inflation. The recent trips to Iraq and Cuba have not helped the negative image that the United States has of Chavez.

By analyzing the economy of Venezuela it is easy to see that because of Venezuela’s dependence on oil revenues, when the price of oil drops, the Venezuelan economy suffers. Inflation occurs when the average level for the price of goods and services increases. In Venezuela’s case inflation was brought on by a number of factors. In order to understand how inflation affects the economy, it is necessary to look at the economic problems that lead to inflation. Next we have to examine the peak period of inflation in Venezuela and the effects it had on the economy and banking systems. Finally we will examine the solutions to ending the high rate of inflation and see how effective these policies will be.

Many economists will agree that the initial problem was the excessive borrowing of funds that Venezuela undertook in the 1970’s. Most of these funds came from the United States. When the U.S. interest rates increased, the rate of payback for Venezuela also increased. This unexpected increase in interest rates put Venezuela in a dangerous position of accruing debt that the government could not pay in a timely manner. All the countries did not feel the boom of business in the 1980’s. In fact the 1980’s are commonly referred to as the “lost decade” for many developing countries. Most of these countries, eager to capitalize on the increase in business, borrowed even more monies to finance new projects. These funds were borrowed at high rates with short terms of payback. Many of the borrowing countries could not keep up with the payments. During the early 1990’s Venezuela’s middle class began to decrease. Some of the people left the country, and others lost their jobs and possessions as the oil prices plummeted. Venezuela experienced a major banking crisis in the early 1990’s, which caused even more people to fall below the poverty line. The banking crisis set the stage for the economic disaster that would drag Venezuela down. As inflation skyrocketed, most of Venezuela’s major banks began to default. By the time the crisis was brought under control, the economy was in shambles. The Venezuelan government had to nationalize the banks in order to regain control over inflation. Before the banking crisis, 132 banks existed. After the government seized control 84 banks remained. This collapse created distrust in the banking system by 1994 inflation in Venezuela was at 65%. Not helping matters was the fact that oil prices were extremely low. Venezuela was in the midst of a recession, and no relief was in sight. According to a graph in The United States and Venezuela, oil prices in 1995 were at an all-time low. The Venezuelan people were feeling the effects of a government that was not prepared to deal with these decreasing oil prices. Because of over-dependence on oil revenues, Venezuela ‘s economy faced high inflation rates for the next five years. During this period political turmoil prevented many investors from pumping money into the struggling economy. The Venezuelan government placed band restrictions on the Bolivar, the Venezuelan currency, in order to bring inflation under control. A high price and low price were placed on the value of the Bolivar although this practice did lessen the inflation, most of the damage had already been done. Consumer and investor confidence was non-existent in Venezuela as well as most other countries in South America. Due to the high rate of inflation, the prices of everyday objects continued to increase as the Bolivar’s value decreased.

The current situation in Venezuela is better than that of five years ago but problems still exist. In “Lenten Diet,” an article that appeared in the February 15, 2002, issue of The Economist, the author states, “ Last week $700 million fled the country”. This occurred because of speculation that the rate of inflation was going to increase. In response to this outflow of funds, the government intervened to keep money in the country. In an article that appeared in The Oil Daily, February 15, 2002, titled “Banks Intervene to Lift Bolivar Amid Regional Uncertainty”, this issue was addressed. Toro explains,” After seeing the Bolivar plunge 20% on Wednesday, Venezuela’s Central Bank, aided by a slew of local banks, stepped in to strengthen the weakened currency in order to protect economic stability”. This reactive measure was done to keep more funds from leaving the country and further devaluing the fragile Bolivar.

The government intervention did succeed in holding funds in Venezuelan banks, but more proactive measures need to be taken. In order to lower inflation and rebuild the struggling economy, Venezuela must no longer solely depend on oil revenues and must diversify its investments. A recent step taken by President Chavez was to float the Bolivar. By doing this, he removed the band restrictions and will allow the Bolivar to set its own value. This is considered risky by some, but most analysts agree that it had to be done. The decision to float the Bolivar was a good move according to the International Monetary Fund. In an article from the Xinhua News agency, International Monetary Fund spokesman Thomas Dalton told reporters, “I believe these are measures that go in the right direction and we’re prepared to provide advice whenever it is needed”. The Venezuelan government also wants to reform the current foreign exchange rate in order to stop capital flight. Owian Johnson, in an article for United Press International, says, “The Central bank currently makes $60 million available to markets every day in three separate auctions”. Johnson goes on to say, “When the Government first abandoned the exchange rate band system, most analysts predicted the Bolivar would drop around 30% against the dollar. But the auctions limited the overall fall in value to about 15% – a figure many economists believe still does not reflect the currency’s true value”. Analysts predict inflation rates to be around 10% for the 2002 fiscal year. This is a great improvement over the 50% inflation rates of the 1990‘s, but policies need to be implemented to assure that inflation does not rise drastically again. Opinions are split on the true value of the Bolivar. Some people believe that the auction system is holding its value up. Others believe that Venezuela is slowly pulling itself out of the recession and accompanying inflation.

The ups and downs that Venezuela’s economy is going through have a direct effect on both the United States banking system and the world banking system. Due to the relative ease of communication and information exchange, a new-world economy has formed. Countries can no longer isolate themselves from the problems other countries face. Venezuela holds a valuable asset that many other countries lack. Because of Venezuela’s oil reserves Venezuela plays an important role in the global market. Due to the political turmoil that many developing countries face, the risk of losing foreign support increases as dissatisfaction within the country rises.

Venezuela directly affects the United States banking system because the U.S. relies on Venezuela for oil. In turn Venezuela relies heavily on the U.S. for manufactured goods. Many of the top U.S. banks have investments in Venezuela and other South American countries. These banks depend on the South American market as much as the European markets. Recently the Venezuelan government began to issue.

Bonds in order to obtain funds to rebuild the banking system in Venezuela. U.S. investors and U.S. banks purchased many of these bonds. Moody’s and Standard and Poor’s, that are investment rating services, rated the bonds as an intermediate risk. This means that while these bonds may return higher yields, there is some risk associated with them. Recent news concerning the floatation of the Bolivar has caused some United States investors to withdraw funds from Venezuela. These investors feel that the Bolivar’s value will drop, and inflation will once again rise. By floating the Bolivar, the Chavez administration lifted the exchange rate band yield, which had kept the value of the Bolivar somewhat constant. In The Currency Game it is stated that, “Countries with long histories of persistent high inflation might be especially tempted to use a fixed exchange rate to bring down inflation”. Investors are worried that because of Venezuela’s past history of high inflation, the Bolivar will lose value once it is floated. By letting the Bolivar set its own price, the Venezuelan Government is taking a huge risk that the Venezuelan economy can support the Bolivar. Yet another problem that will affect the U.S. banking system is that the U.S. lent sufficient amounts to Venezuela during the 1980’ and 1990’s. If Venezuela defaults on these loans; the U.S. consumer will feel the crunch. The banking crisis that Venezuela experienced has caused many companies not to invest in the country until they can be assured that the national banking system is working properly.

Venezuela’s problems also have a direct influence on the world banking system. Venezuela is not alone. Most investors are staying away from South America as these developing countries try to fix their problems internally. Countries such as Argentina defaulting on World Bank loans may cause other countries to not receive the help the need. Venezuela is still attractive to foreign investors; there is a great demand for consumer goods that the country itself cannot meet. The political turmoil that’s taking place in Venezuela is a major cause for the lack of overseas investing. The Chavez administration is trying a variety of ways to jump-start the struggling economy. Many world bankers are closely monitoring the exchange rate as a way to gauge the direction the Venezuelan economy is headed. These investors want to be assured that prior inflation and bank’s problems are under control before they sink money into the country. Venezuela’s overall attractiveness to investors is still low, and not until changes are made will Venezuela see an increase in foreign investment.

Venezuela is a country at a crossroads; Venezuela remains an important part of the world’s economy because of oil but lacks the economic stability to become a world power. Because of the large deposits of oil, Venezuela receives help that most other South American countries do not receive. Because Venezuela receives a large quantity of exports from the United States, a stable Venezuelan economy is good for U.S. suppliers. Venezuela must do a number of things in order to obtain foreign investment. First, it is necessary for political stability to be established. Many investors will not put money into a country they feel is unpredictable. President Chavez must regain control of the government and start to implement his objectives of political reform. Second, Venezuela must set up programs to prevent another banking crisis like the one that hurt the country in the 1990’s. These programs should also include controls to stop inflation and capital flight. Finally, Chavez needs to implement social welfare programs in order to boost the morale of the poor people. Chavez must show the other countries that he is interested in the overall welfare of Venezuela, not just the political side.

The economy of Venezuela has to change, so the problems of the 1990’s do not resurface. By depending solely on oil revenues, Venezuela dug itself into a hole that Venezuelans are now trying desperately to get out of. The banking crisis and the following high levels of inflation have caused billions of dollars to leave the country at a time when investments were necessary to keep Venezuela afloat. The United States and the world banking system felt the problems that Venezuela experienced. Recent steps in the banking industry have Venezuelans hoping that former investors will regain confidence and once again start investing in Venezuela. This influx of foreign capital is necessary for Venezuela to rebuild its economy.